what the Western central bankers and finance ministers felt, it would
be "impotence." We knew that what was left of the Soviet Union was crumbling;
we knew the armed forces hadn't been paid and that a collapse of the
military could pose a serious threat to world peace. We had grave concerns
about what would happen to the nuclear weapons. The deterioration was
internal and political. All the IMF could do was talk about money, and
money wasn't the problem. We ended up doing what organizations usually
do under such circumstances: we delegated a committee for further study
and discussion (in this instance, the deputy finance ministers of the G7
were to go to Moscow in a few weeks for consultations). So it was up to the
Soviet reformers. The challenges they faced were more difficult than those
that had confronted their counterparts in Eastern Europe. The Polish and
Czech leaders had been able to draw on the goodwill of the population—as
trying as the economic circumstances may have been, their nations were
being liberated from Moscow's grasp. But many Soviet citizens had prided
themselves on their country's superpower status and had sacrificed much
to help achieve it. For them, the upheavals meant nothing but sorrow—a
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THE AGE OF TURBULENCE
great loss of national prestige. Humiliation made the reformers' tasks much
harder.
What's more, too many years had gone by in the Soviet Union since
1917—scarcely anyone alive even remembered private property or had
firsthand business experience or training. There were no accountants, auditors,
financial analysts, marketers, or commercial lawyers, even among retirees.
In Eastern Europe, where Communism had reigned for forty years
instead of eighty, free markets could be restored; in the Soviet Union, they
had to be resurrected from the dead.
Gorbachev did not stay in power long enough to oversee the market
reforms; he resigned in December 1991 as the Soviet Union formally broke
up and was replaced by a loose economic confederation of former Soviet
republics. "End of the Soviet Union; Gorbachev, Last Soviet Leader, Resigns;
U.S. Recognizes Republics' Independence" read the headline of the
New York Times on December 26—I looked at it and felt regret that Ayn
Rand hadn't lived to see it. She and Ronald Reagan had been among the
few who had predicted decades before that the USSR would ultimately
collapse from within.
The man Boris Yeltsin chose to launch economic reforms in Russia was
Yegor Gaidar. In the 1980s when he and other young economists had
dreamed of creating a market economy in the Soviet Union, they'd imagined
an organized, methodical transition. But now, amid growing chaos,
there was no time for that—unless the government could jump-start the
markets, people might starve. So in January 1992, Gaidar, as Russia's acting
prime minister, turned to the scheme that had worked in Poland: abruptly
ending price controls.
Shock therapy jolted the Russians much more than it had the Poles.
The size of the country, the system's rigidity, the fact that the state had dictated
prices for people's entire lives—it all worked against them now. Inflation
rose so fast that people's wages, when they could collect them, became
worthless, and their meager savings were wiped out. The ruble lost three
quarters of its value in four months. Goods remained in scarce supply in
the stores, and the black market flourished.
Then, in October, Yeltsin and his economists unleashed the second
massive reform: they issued vouchers to 144 million citizens and started
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TH E FALL OF TH E WALL
privatizing state-owned enterprises and real estate on a massive scale. This
reform, too; was far less effective than in Eastern Europe. Millions of people
ended up with stock in businesses or owning their apartments, which was
the goal, but millions more were bilked out of their vouchers. Entire industries
ended up in the hands of a small number of opportunists who came to
be known as the oligarchs. Like Jay Gould and some of the railroad tycoons
in nineteenth-century America who built vast fortunes in part by manipulating
government land grants, the oligarchs constituted an entirely new
wealthy class and compounded the political chaos.
I
I
was fascinated to see these events unfold. Economists have had considerable
experience observing how market economies convert to centrally
planned ones—indeed, the shift toward Communism in the East and socialism
in the West was the dominant economic trend of the twentieth
century. Yet until recent years we have had little exposure to movement in
the opposite direction. Until the wall fell and the need to develop market
economies out of the rubble of Eastern Europe's central-planning regimes
became apparent, few economists had been thinking about the institutional
foundations that free markets need. Now, unintentionally, the Soviets were
performing an experiment for us. And some of the lessons were startling.
The collapse of central planning did not automatically establish capitalism,
contrary to the rosy predictions of many conservative-leaning politicians.
Western markets have a vast underpinning of culture and infrastructure
that has evolved over generations: laws, conventions, behaviors, and business
professions and practices for which there was no need in a centrally
planned state.
Forced to make the shift overnight, the Soviets achieved not a free-
market system but a black-market one. Black markets, with their unregulated
prices and open competition, seemingly replicate what goes on in a
market economy. But only in part. They are not supported by the rule of
law. There is no right to own and dispose of property backed up by the enforcement
power of the state. There are no laws of contract or bankruptcy,
and no opportunity to take disputes to court for resolution. The linchpin of
a free-market economy, property rights, is missing.
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THE AGE OF TURBULENCE
The result is that black markets bring few of the benefits to society of
legally sanctioned trade. Knowing that the government will protect one's
property encourages citizens to take business risks, a prerequisite of wealth
creation and economic growth. Few will risk their capital if the rewards are
going to be subject to arbitrary seizure by the government or mobsters.
By the mid-1990s, that was the picture across much of Russia. For generations
of people who had been brought up on the Marxist notion that
private property is theft, the shift to a market economy already challenged
their sense of right and wrong.* The rise of the oligarchs further undermined
popular support. From the start, law enforcement in defense of private
ownership was extremely uneven. Private security forces to a large
extent took over the job, sometimes warring with each other and further
aggravating the sense of chaos.
It wasn't at all clear that the Yeltsin government itself understood how
a market economy's legal system must work. In 1998, for instance, an influential
Russian academic told the Washington Post: "The state thinks .. . private
capital should be defended by those who have it.... It's a completely
conscious policy of the law enforcement authorities to remove themselves
from defending private capital." To me this suggested a basic ignorance of
the need to embody property rights in the judicial system. The use of rival
private police forces is not the rule of law; it is the rule of fear and force.
Trust in the word of others, especially strangers, was another element
conspicuously lacking in the new Russia. We hardly ever think about this
facet of market capitalism, yet it is crucial. Despite each person's right in
the West to file a lawsuit to address a perceived grievance, if more than a
small fraction of contracts were adjudicated, our courts would be swamped
to the point of paralysis. In a free society, the vast majority of transactions
are thus, of necessity, voluntary. Voluntary exchange, in turn, presupposes
*Marx was hardly the first to condemn private ownership; the notion that private property is
sinful, along with profit making and lending at interest, has deep roots in Christianity, Islam,
and other religions. Only with the Enlightenment did countervailing principles emerge to provide
a moral basis for ownership and profit. John Locke, the great seventeenth-century British
philosopher, wrote of the "natural right" of every individual to "life, liberty and estate." Such
thinking profoundly influenced America's Founding Fathers and helped foster free-market
capitalism in the United States.
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TH E FALL OF TH E WALL
trust. I have always been impressed that in Western financial markets, transactions
involving hundreds of millions of dollars often are simply oral
agreements that get confirmed in writing only at a later date, and at times
after much price movement. But trust has to be earned; reputation is often
the most valuable asset a business has.
T
T
he fall of the Soviet Union concluded a vast experiment: the long
standing debate about the virtues of economies organized around free
markets and those governed by centrally planned socialism is essentially at
an end. To be sure, there are still a few who support old-fashioned social
ism. But what the vast majority of the remaining socialists now advocate is
a highly diluted form, often called market socialism.
I am not alleging that the world is about to embrace market capitalism
as the only relevant form of economic and social organization. Vast num
bers of people still consider capitalism with its emphasis on materialism
degrading. And one can seek material well-being and yet view competitive
markets as subject to excessive manipulation by advertisers and marketers
who trivialize life by promoting superficial and ephemeral values. Some
governments, such as that of China, even now attempt to override the evi
dent preferences of their citizens by limiting their access to foreign media,
which they fear will undermine their culture. Finally, there remains a latent
protectionism, in the United States and elsewhere, which could emerge as
a potent force against international trade and finance and the free-market
capitalism they support, particularly if today's high-tech world economy
should falter. Nonetheless, the verdict on central planning has been ren
dered, and it is unequivocally negative.
141
SEVEN
A DEMOCRAT'S
AGENDA
O
O
n the evening of February 17,1993,1 found myself in the uncomfortable
glare of the TV lights at a joint session of Congress,
sitting between Hillary Clinton and Tipper Gore. The front row
of the gallery was not exactly where I'd expected to be for President Clin
ton's first major congressional address. I had assumed that my invitation to
sit with the First Lady was a matter of courtesy and that I'd be at the back
of the box with White House aides. I guess it was nice to know that the
Federal Reserve was considered a valuable national asset after the some
what less than favorable embrace we'd gotten from President Bush, but
obviously I'd been positioned up front for a political purpose. Mrs. Clinton
was wearing a bright red suit, and as the president spoke, the cameras fo
cused on us again and again.
Afterward it turned out that not everyone had been pleased to see me
there, on the grounds that it might compromise the independence of the
Fed. I had no intention of doing that, of course. But I was intent on building
a working relationship with this president, who seemed seriously fiscally
responsible.
A DEMOCRAT'S AGENDA
I'd met Clinton in early December, when he was president-elect. He
hadn't moved to Washington yet, so seeing him meant flying out to Little
Rock, Arkansas. He and his transition team had set up shop there in the
governor's mansion, which turned out to be a big redbrick building with
white pillars set on acres of flat lawn and gardens near the center of town.
As I was ushered into an anteroom, I wasn't sure what to expect. One
thing I'd heard, though, was that he always ran late, so I'd brought along
some economic reports to read and busied myself for twenty minutes or so
until he appeared. "Mr. Chairman," he said, striding toward me smiling and
reaching to shake hands. I could see why he was reputed to be a great retail
politician. He made me believe he really had been looking forward to seeing
me.
Clinton had outlined a broad, ambitious economic agenda during his
campaign. He wanted to cut taxes on the middle class, halve the federal
deficit, stimulate job growth, increase U.S. competitiveness through new
education and training programs, invest in the nation's infrastructure, and
more. I had seen, and been part of, too many presidential campaigns. Candidates
promised something for everybody. But I wondered what Clinton's
real priorities were. He must have been reading my mind; one of the first
things he said was: "We need to set our economic priorities, and I'm interested
in your outlook on the economy."
From the Fed's perspective, if he wanted to address the economy's
long-term health, the deficit was by far the most pressing concern. I'd made
that argument at the start of Bush's term, and now the problem was four
years worse. The national debt held by the public had risen to $3 trillion,
causing interest payments to become the third-largest federal expense after
Social Security and defense. So when Clinton asked for my economic assessment,
I was ready with a pitch.
Short-term interest rates were rock-bottom low—we'd cut them to 3
percent—and the economy was gradually shaking off the effects of the
credit crunch and growing at a fairly reasonable pace, I told him. More than
